What do you understand by the term financialization? What factors are driving US firms to distribute more of their cash to shareholders?
The Bombardment of the psyche of the average citizen by the financial industry in newspapers, magazines, television and the internet offering different financial services from mortgage loans to credit cards brings to mind a question raised by Ismail (2008:1) “ … if finance is everywhere does this mean that we have in some sense become financialized.” This essay sets out to answer Ismail’s question and give a better understanding of the term financialization. Firstly various view points and opinions of the academia, economic journalist, politicians and analyst in mainstream finance will be reviewed with the aim of examining financialization from their different perspective. Secondly, the relationship between financialization, shareholder value, fair value accounting, share buy-backs, value creation, value at risk and value absorption will be examined to show how they are all interconnected in the process termed financialization. Further more factors driving the increasing distribution of cash to shareholders by US firms will also be discussed and how all these factors are geared towards achieving one singular goal – the creation of value for the shareholder.
Nolke and Perry (2007) views financialization from two perspective: Profit financialization and Control financialization. Nolke & Perry asserts that Profit financialization is where an organisation makes a greater proportion of its profit from financial activities relative to profit made from its production activities while Control financialization is described as the process by which shareholder value creation is the primary goal of the managers of a firm. Krippner (2005:2) defines financialization as “a pattern of accumulation in which profits accrue primarily through financial channels rather than through commodity production,” this assertion by Krippner further strengths the argument put forward by Nolke & Perry that financialization is the addition of financial services to the operation of a non-financial institution an example would be Ford Motors that has incorporated auto financing into its operations.
Anderson et al (2008:2) uses the term financialization to describe “ the implications of combining an active market for corporate control with fair value reporting where corporate capital market transactions are now accounted for at market value,” in this view point the proponents are researching how financialization is used to direct corporate strategy in order to achieve the goal of shareholder value creation. Anderson et al uses the term financialization to describe all the processes and transformation involved in creating value for the shareholder.
To create shareholder value, a firm must strive to ensure its financial performance are such that market analyst will mark up its shares for good performance, one of the indices used by analyst is the Earnings per Share (EPS) of the firm. The firm can only increase its EPS by increasing its cash earnings over its outstanding shares issued, the firm has two choices either to increase its cash earnings by reducing expenses on production, and capital expenditures which can only be done over the long term. The firms other choice is involves the reduction of its outstanding shares issued by employing a share buy-back strategy.
The share buy-back strategy involves a firm using cash either from its own operation or raised by way of debt to buy – back its outstanding shares issued resulting in an increased EPS and leading to a rise in its market price. This process results in an increase in shareholder value and creates a huge holding of treasury stock, which the firm can issue to acquire another firm or issue as options to its employees as a further incentive to continue to deliver shareholder value.
If the firm decides to acquire a new firm, according to Anderson...
References: Ismail E. et al (2008) “Financialization at work : Key Texts and Commentary.” London : Routledge.
Krippner, G. R. (2005). “The financialization of the American economy.” Socio-Economic Review, (3) 173-208.
Lazonick, W. and O’Sullivan, M. (2000) “Maximizing shareholder value : A new ideology for corporate governance.” Economy and society, 29(1), 13-35
Nolke, A. and Perry, J. (2007). “The Power of Transnational Private Governance: Financialization and the IASB.” The Journal of Business and Politics, 9(3). Article 4
Weston, J. F and Siu, J.A (2003) “Changing motives for Share Repurchases” Working Paper : Anderson Graduate School of Management Finance (University of California, Los Angeles) Paper 303.
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